Is it worth punting on Baby Bunting?

The word is out: don’t buy from private equity. That lesson has been learnt after years of poor deals which saw private equity firms dress up sales and cost figures, add lashings of debt and cut expenditures.

The aim is always to present the business at its best and, especially, to make it look like it consumes less cash than it really does. This has been the formula for so many disastrous private equity offerings: Myer (ASX: MYR), Pacific Brands (ASX: PBG), Boart Longyear (ASX: BLY) and Calibre (ASX: CGH) all come to mind as classic private equity plays that have worked for the seller but not for the investor.

So scepticism about private equity sales is well earned. Every now and then, however, an interesting business pops up from the private equity cellar. Last year’s iSentia (ASX: ISD) was one; Baby Bunting, a retailer of infant goods, may be another.

Baby Bunting will list on the ASX and use cash raised to increase store numbers. Current private equity owner TDM Asset Management will retain a chunk of equity.

The sector isn’t an obvious stage for success; large competitors Babyco and Mothercare have gone bust in recent years and the internet is an enormous threat because it facilitates both online competition and markets for selling used goods. Yet Baby Bunting looks ok.

As a new parent myself, I remember how confounding baby shopping was and how lost my wife and I were as we started. Like many would-be parents, we expected to get everything cheaply and easily online but quickly discovered the internet wasn’t an option.

Unfreezing your wallet

New parents need advice on what to get, what to avoid and what is best. Taking risks on a cheap or untested product is fine for myself but not for my unborn progeny. I was already nervous about my prospects as a father; I wasn’t about to confirm those doubts by buying the cheapest stuff I could find. I found that shopping for an unborn or newly born child has the amazing effect of freezing your rationality and unfreezing your wallet.

This seems to be a common trend in the industry: parents are now older and command more financial resources than ever before. They aren’t price sensitive when it comes to their offspring but they are clueless when it comes to purchases, a useful combination for a retailer.

This is where Baby Bunting can exploit a key advantage: the army of enthusiastic working mums who work the sales floor. They know the products first hand, enjoy advising novices and can sell with an authenticity and knowledge that online, discount and department store competitors can’t match.

By building scale and hence purchasing power, staying out of high rent malls and turning over plenty of stock, Baby Bunting is able to offer similar prices to discounters and better service than department stores.

The product range is wide – everything from cots and nappy bins to prams and car seats – and they offer important ancillary services such as installations, deliveries and laybys. The business has a format that works; revenues have risen almost fourfold since 2008 and Baby Bunting is now the largest seller in the segment with an estimated 10% market share.

Long runway

With just 31 stores, there is a long runway for rolling out new stores and management is aiming to have about 70 in the medium term. Current revenue numbers suggest average revenue per store of about $5.5m, which appears high.

There are several reasons for that. My hunch is that the average spend per customer is high, with customers buying bundles of goods rather than a single item. Store sizes aren’t overly large so inventory turn and sales per square meter should also be impressive.

There are two key risks. One is from the store roll-out program where newer locations are likely to be less profitable so incremental returns could fall. That is true of most store roll-outs but particularly relevant here because the favourable demographic trends – double income households, older parents with more cash, fashion conscious consumption habits – work best in urban locations.

The second risk is the price. There is nothing secret about the success of the business and it is likely to be generously priced. Early reports indicate the float will list with a price-earnings ratio of 20. That's high enough to dampen enthusiasm especially when added to risks posed by weak domestic economic conditions.

Yet the business has grown more than 20% a year over the past six years and, if it works, the store roll-out could sustain high growth rates for years. This is one private equity offering that's worth a look.

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